The new EU banking package published in October 2021 implements the Final Basel III into banking regulation in the form of the Capital Requirements Regulation (CRR3) and the Capital Requirements Directive (CRD6). One of the key elements of the Final Basel III framework is a more granular but less sensitive recalibration of the credit risk (CR) weighting calculations under the Standardised Approach (SA). This is particularly punitive in the case of securities financing transactions (SFTs) since it does not recognize the relatively short-term nature of SFTs in the case of exposures to non-banks. Accordingly, this results in the Risk Weighted Asset (RWA) computations for SFTs with many key market participants under the SA being multiples of those calculated under banks’ Internal Model Approach (IMA).
This contrasts to the treatment of short-term SFT exposures to banks for which Final Basel III recognises their lower risk. There is no explanation as to why short-term exposures with non-banks are treated less favourably.
Banks that rely on IMA do have more flexibility in adjusting RWAs for SFTs to account for both internal ratings and the relatively short maturities of the underlying transactions. However, Final Basel III also introduces the output floor (OF), which sets a minimum for capital requirements calculated under banks’ IMAs at 72.5% of those required under the SA. In the case of SFTs, the unequal treatment for RWAs under the SA will be problematic for banks that use either the SA or the IMA, with considerable impacts for SFT capital requirements. In turn, this will affect the cost of offering this service, as well as liquidity in the related securities markets, since SFTs are instrumental in supporting market-making. This will not only impact securities investors such as insurance and pension funds, but also securities issuers, including corporates and sovereigns.
This comes at a time when the ability of many different investors to access the repo market on a consistent basis is very much in the spotlight, as are concerns about dislocations in the eurozone sovereign bond market following the wind-down of the ECB purchase programmes, as well as reduced liquidity in corporate bond markets. Making short-term repo markets more expensive and less liquid for critical market participants, including market-makers, seems counterintuitive.
The ICMA ERCC would therefore propose that the RWA calculation for short maturity SFTs under the SA be adjusted to reflect better their short-term nature and relative importance to overall market functioning. This would also be consistent with other aspects of the SA that take into account the short-term nature of certain exposures.
The full paper is available at https://www.icmagroup.org/assets/documents/Regulatory/Repo/ICMA-ERCC-Position-Paper_Prudential-Treatment-of-SFT-counterparty-risk-under-standardised-approach_July-2022-050822.pdf